Tax Expenditures Are a Poor Way of Subsidizing Infrastructure Investment
(cc photo by moaksey)
The intuitive consequence of the U.S. political system’s aversion to taxes is lower levels of public services and public infrastructure. In reality, however, one major consequence is a tendency to provide services and infrastructure through relatively inefficient methods. The reason is that there are two ways for the government to try to finance things. One is to spend more money and the other is to create a special tax break. Either of these things implies offsetting tax increases in the long run. But the tendency is for conservatives and centrists to treat “tax cuts” as good and “spending” as bad, thus putting a big thumb on the scales in favor of using tax expenditures rather than spending.
One special case of this is the use of tax-exempt bonds to finance infrastructure investment. The federal government exempts certain classes of bonds from income taxation, typically bonds issued by state and local governments to finance investments in school construction or transportation. This subsidizes infrastructure investment and it costs money. A different approach would be to just spend federal dollars on subsidizing infrastructure investment. The CBO and the Joint Committee on Taxation have a new study out on the issue concluding that this tax expenditure approach is highly inefficient. As the Director’s Blog explains:
That study concludes that the amount that the federal government forgoes through tax-exempt bond financing is greater than the associated reduction in borrowing costs for state and local governments. Some analysts have estimated the magnitude of that differential and conclude that several billion dollars each year may simply accrue to bondholders in higher income-tax brackets without providing any cost savings to borrowers.
The reason is that the value of the subsidy is shared between the infrastructure project and the buyer of the bond. Consequently $1 in federal tax expenditure generates less than $1 in reduced borrowing costs. In fact, according to the report “only about 80 percent of the tax expenditure from tax-exempt bonds actually translates inot lower borrowing costs for states and localities, with the remaining 20 percent simply taking the form of a federal transfer to bondholders in higher tax brackets.”
In other words, the approximately $7.5 billion in annual lost tax revenue is generating only $6 billion in additional infrastructure investment.
15 Responses to “Tax Expenditures Are a Poor Way of Subsidizing Infrastructure Investment”
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October 29th, 2009 at 4:49 pm
Sorry, no. Check your reading and math again: 80% lower borrowing costs, 20% transfer to rich bondholders. Only $1.5bn is wasted. Still stupid, but not $6bn stupid.
October 29th, 2009 at 4:59 pm
that’s bangkok, isn’t it?
interesting that they show the infrastructure of the city center. the outer parts are a nightmare (although the river isn’t the worst way to get around)
October 29th, 2009 at 5:10 pm
Local infrastructure spending funded through tax exemption does have the advantage of not having to go through the congressional appropriations process.
October 29th, 2009 at 5:13 pm
Muni bond interest are exempt from fedl income tax because of a clause in the constitution that forbids that feds from interfering with state (and local) govts raising revenue. US treasury bond interest is exempt from state income taxes for the same reason.
The courts did make an exemption for this when lots of states started to issue bonds for subsidized loans to firms building factories in said states, these states were issuing a federal tax abatement on the sly. These bonds were declared taxable and as a consequence aren’t issued anymore.
Maybe now that the Feds own GM, they’ll be another court case, this time as to why NY cannot tax treasury interest.
October 29th, 2009 at 5:31 pm
I thought that was the one in Seattle.
There was a rumor a while back that the new part of the monorail had to go within something like six inches of the troll’s nose.
October 29th, 2009 at 6:01 pm
Wow! One of my favourite websites has used one of my photos! What an awesome surprise! Hehe…
Yep – it is Bangkok…
October 29th, 2009 at 7:01 pm
Left hand driving.
SKYTRAIN!
October 29th, 2009 at 8:03 pm
Which of your two updates is true? Surely they cannot both be.
And, if it is still needed, </snark>
October 29th, 2009 at 8:11 pm
I’ve skimmed the CBO paper and I don’t see any modeling or convincing discussing that supports the claims made in the paper. Tax incidence and efficiency questions are pretty messy and non-intuitive, especially in economies with pre-existing distortions (tax wedges, various sorts of market power and financial constraints), and I just don’t see the work here to make the numbers cited credible or meaningful.
I would buy the claim that bond underwriters have too much influence on state and local treasurers and receive excess profits, so replacing non-federal bond issuance by a federal financing mechanism might be a good idea and reducing tax expenditures might be a first step in that direction. But that’s not the claim being made here. How about a GSE for state and local government bond issuance?
October 29th, 2009 at 10:23 pm
Tax Expenditure–the scurvy idea that the Government owns all income and by NOT collecting it, they are spending it by giving it back to the rightful owners–the People who earned it.
October 29th, 2009 at 11:00 pm
There is another effect, a temporal difference between the benefit (project) and paying for it -at least to the extent that bonds (borrowing) replaces budget expentitures. The bulk of the cost of the project is off budget for several years. So the politicians benefit by getting credit for another boondogle, and by the time the citizens think to ask about the debt servicing costs, the memory of how the debt was acquired is gone.
But, I think it is unfair to state that the tax benefits only acrue to the very wealthy. I’ve always been five to ten percentile from the top, and always owned a modest number of muni bonds. So at least some of those breaks extend well beyond the top 1%. And because of the alternate minimum tax, there is a limit to the fraction of income that can be sheltered via tax exempt bonds (or favorable rates for dividends and interest).
October 30th, 2009 at 1:59 am
CBO: “several billion dollars each year may simply accrue to bondholders in higher income-tax brackets without providing any cost savings to borrowers.”
Waste is bad. So is graft. But you can live with it as long as it is doesn’t add layers of complexity and obfuscation. Extra layers of anything add time and time is something we don’t have.
We need a Green Bank is right. Streamline and simplify is my motto. There will be some inevitable boondoggles, but they will be sitting right there, for all to see (transparency!) and therefore understandable and correctable; and someone can be held responsible, unlike the horseshit that does down within the MID.
Once a Green Bank gets rolling it will get better at what it does. Once established it will be impossible to root out. It will become an American institution -a place, a center, a meeting ground, for thinkers, dreamers, and patriots.
October 30th, 2009 at 2:18 am
@7 PanAmerican: “SKYTRAIN!”
Great picture. How cool is that. That’s the dream, isn’t Matty, instead of aqueducts we have skytrains crisscrossing the country. From coast to coast, solid but sleek concrete skyducts built to allow trains the possibility of approaching mach speeds, if they so choose.
October 30th, 2009 at 8:31 am
I thought at first it was just another much heralded typo, but the consistent use of ‘tax expenditures’ as something that does *not* equal ’spending’ but that *does* equal ‘tax cuts/breaks/exemptions/etc’ is completely confusing.
October 30th, 2009 at 10:02 am
[...] Matthew Ygelesias on the always exciting subject of the efficacy of tax expenditures. [...]